Other Diseconomies


Although related to the problems of bureaucratization the diseconomies that fall into this category arise from a different phenomenon: the tendency for a facility, as it grows in size, to be assigned more and more products, processes and specializations. As mentioned in our earlier discussion of the difference between size and scale, combining dissimilar activities does not reduce complexity, it merely locates it under the same roof.  Unless this complexity is managed carefully, the firm can begin to work at cross purposes and even dissolve into chaos.

Our observations suggest that the number of people whose role is primarily one of coordination across functional or departmental boundaries tends to increase more than proportionally with the number of separately managed units (departments, functions, process stages etc.,) in a facility. This phenomenon is similar to large networks (railroads, truck lines, computer networks, etc.,), where the supervisory costs (those associated with supervising the operations of each unit) increase in rough proportion to the number of units,  but the coordination costs  increase with the number of linkages  between units. In general, the number of links between N nodes in a network

= N (N – 1) / 2

For example a network with four units (shipping terminals, product lines, process stages, etc.,) has six links among them. If another unit is added to the network, the number of links goes up to ten. In other words, its supervisory costs will increase by 25 per cent but its coordinating costs will increase by 67 per cent. Going to six units increases the number of links to fifteen,

The larger a facility, and the more responsibilities a company places, on it, the more dependent it becomes on its successful operation. Should it experience a natural disaster (fire, flood, earthquake etc.)  or a human one (strike, accident, mismanagement), the company’s performance as a whole may be seriously impaired. To reduce their vulnerability to the kind of risks that are associated with putting too many eggs in one basket companies often prefer to divide the production of certain critical products, components or services among two or more separate locations.

In summary, diseconomies of scale are just as real and important as economies of scale, even though they seldom receive equal attention by economists. The management literature on the other hand, increasingly recognizes that small companies and plants often outperform their larger competitors. Even today, however, too many companies seem to regard diseconomies of scale as the result of a set of factors that good managers should somehow be able to overcome.

Managers and economists tend to focus primarily on the kinds of clearly observable scale economies and diseconomies described above. They can see the advantages to making more of something, and the disadvantages of being too big. The advent of information intensive networks, however, has focused increasing attention on a phenomenon that until recently was of little practical interest; the possibility of increasing economies of scale.  The value of certain kinds of networks can increase faster than the number of users, because each new user adds potential value to all the existing users. The more companies join a business to business (B2B) network, for example, the more opportunities each will have to locate new/better customers and sources of supply. The result is that large networks can become so valuable they discourage the formation of competing networks, resulting in a winner take all monopoly. The dominance of Microsoft’s Windows operating system, which has induced applications programmers, computer manufacturers, and Internet providers to configure their products and services around it, was one of the reasons the United States and other countries instituted antitrust suits against the company.

The basic concept is straightforward: as the size of a facility increases it can exploit more and more scale economies but it also becomes increasingly subject to diseconomies. That is, the marginal cost curve goes down over some range, and then begins to increase. Management’s task, therefore is to select the size that allows it to create and deliver its products and services at the lowest cost, or with the highest total profit (which sometimes leads to a different answer) and at the same time is compatible with the company’s values and attitudes regarding competitive priorities, desirable working environments,  and risks  of various types.

Determining the best size for a facility in practice involves rough approximations, and is usually based more on “gut feeling” than on factual data. It is difficult both because it is hard to distinguish the impact of “bad management” from “wrong size”, and because it depends on a number of situational factors, such as the facility’s age and its general environment, labour, government, market, competition,  and technology all of which change over time . Over the past several decades, technologies have been developed in a number of industries that permit efficient operation at much smaller volumes than was true in the past.